The “Brussels Effect” Has a Real Influence on US Crypto Regulation

The right to privacy is enshrined in many legal traditions around the world. In the United States, it is protected by the Fourth Amendment; in the European Union, it falls under Article 8 of the European Convention on Human Rights. Although definitions differ from jurisdiction to jurisdiction, most of us are entitled to a reasonable expectation of privacy in our correspondence, in our homes and about our persons.

In the 1970s, businesses, families, and individuals began to generate data like never before, and the extent to which it fell within existing privacy mandates was increasingly unclear. This data proliferation was first recognized as a problem in the late 1970s and accelerated in the decade that followed. In response, the EU introduced its Data Protection Directive in 1995, guaranteeing certain fundamental rights around the processing of personal data.

The crucial thing to understand in this context is that an EU directive leaves it up to member states to determine how it will be incorporated into national laws. This is a recommendation and not a regulation that would legally oblige members to apply the laws from a specific date.

From 1995, privacy regulation in the EU has come a long way. First a guideline, it eventually became the General Data Protection Regulation (GDPR), which became a legal requirement in 2018.

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The GDPR has become the benchmark for privacy law and has influenced regulation in other jurisdictions, including the United States. It’s a phenomenon that Anu Bradford coined the ‘Brussels effect’, where EU legislation sets the global regulatory standard. We have seen it happen in a number of areas other than data privacy, such as environmental law and online hate speech, which often enter the United States through a similar mechanism: “the ‘California Effect’, whereby California sets a strict standard which is then widely adopted in the United States.

And now there is another industry ready to follow this well-trodden path – from EU directive to EU regulation to global regulatory standard.

The case of Tornado Cash – which saw a protocol designed to hide financial transactions and increase privacy shut down by regulators due to its use by bad actors – is an example of why regulation is so vital to the decentralized finance (DeFi). Infrastructure must be built along regulatory lines.

Like data in the 1980s, the proliferation of digital securities and the broader DeFi space is inevitable. Regulation will be key to supporting innovators, promoting innovation and protecting investors, not to mention the widespread adoption of digital securities trading globally.

In the United States, digital securities fall into a regulatory gray space, with neither the Securities and Exchange Commission nor the Commodities Future Trading Commission willing to put their heads above the parapet and claim responsibility.

In California, the regulation of digital assets is an ongoing conversation, and the Senate should push for an amendment to California’s financial code to include digital assets: the Digital Financial Assets Act. If adopted, it will be enforceable from 2025.

By contrast, EU regulators have been quicker to master DeFi. The German regulator, specifically the Federal Financial Supervisory Authority, or BaFin, has gone to great lengths to encourage innovation and is offering a regulatory plan for DeFi elsewhere. A 2020 amendment to German banking law put crypto assets on par with traditional securities.

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In Brussels, regulation is also accelerating. The European Crypto-Asset Markets (MiCA) will come into effect in the fourth quarter of this year and launch an 18-month transition period for member states. Meanwhile, the recently released European Financial Stability and Integration Review 2022 showed a commendable understanding of the sector. He advocated rethinking the current regulatory approach, focusing regulation on the activity rather than on an entity.

It’s still early days when it comes to DeFi. However, digital securities regulation in the EU may well follow a similar path to that which led to the GDPR. Brussels issued an opinion this year on regulation by activity, which we could eventually see integrated into its directive on the markets of financial institutions. (A directive, remember, is a guiding recommendation for member states.) From there, it could become a regulation under MiCAR.

With a concrete example of DeFi regulation to build on and decentralized finance becoming the technology layer where ultimately the entire financial market will move, other regulators will follow. Indeed, jurisdictions like Israel have made it a habit. The question is whether the United States will be influenced more by the “Brussels effect” or the “California effect”.

Philippe Pieper is the co-founder of Swarm, a regulated DeFi platform in Germany.

This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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